Angelo Taningco
Economist, Treasury Group

The Philippine government has maintained its fiscal deficit target for this year at 3.0% of GDP but raised it for next year to 3.2%. In H1, we estimate the fiscal deficit at 2.3%. The IMF recommended that the government ought to maintain its fiscal deficit at 2.4% for both 2018 and 2019 in order “to support efforts to contain inflationary pressures.” Headline inflation in H1 averaged 4.3%, already above the government’s target range of 2% – 4%. The government’s economic managers took note of the IMF proposal but emphasized that the high inflation this year is brought about by transitory factors. The central bank projects inflation to remain above the government’s target this year but to decelerate towards the target range starting next year.

Economic theory suggests that fiscal deficits are inflationary. Empirical evidence spanning multiple countries and covering long-run periods indicate fiscal deficits having a strong (weak) inflationary impact during high (low)-inflation episodes. We observe that the Philippines often exhibits fiscal deficits, which we estimate to have averaged at 2% of GDP over the last 30 years or so. We also find the country having experienced episodes of high and low inflation. Since the BSP adopted an inflation targeting approach in 2002, actual inflation was higher than the government’s target range during 2004-2006 and 2008, with these years manifesting cost-push inflation, i.e., inflation driven by supply-side factors. Our empirical exercise on the Philippines spanning the 1986-2017 period, however, shows a lack of statistically significant relationship between fiscal deficit and inflation. These findings suggest that fiscal deficits that are within targets are not that inflationary in the domestic economy. This implies that the government’s fiscal deficit program would not pose an inflation risk. We maintain our full-year 2018 forecasts on inflation and fiscal deficit of 4.7% and 2.7%, respectively. For next year, we expect inflation to be within target at 3.3% and the fiscal deficit to stay at 2.7%.

Figure: Fiscal Indicators Balance & Inflation

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